Cliffs Natural Resources Is a Sell

Cliffs Natural Resources (CLF) announced first quarter ended March 31, 2016 total revenue of $305.5 million, down 31.5 percent year-over-year from $446.0 million during the same period last year.

Cliffs Natural Resources declared first quarter of 2016 net income of $116.8 million or $0.62 per diluted share compared to a net loss of $761.7 million or $5.04 of loss per diluted share in first quarter of 2015.

The key natural resources company reported continued year-over-year decline in its top line primarily driven by the ongoing weaker global commodity demand and pricing environment, negatively impacting the company’s key margins.

What gives?

The global iron ore prices have continued to fall since the start of 2014, when the key metal prices were recorded at US $134 per ton.

The iron ore price declined to its lowest point during the start of April 2015 to about US $47.50. This significant fall in iron ore prices in less than a year and a half time signifies that the key metal’s production is controlled by a few economies including the Rio Tinto mine in Australia that produced 257 million tons of iron ore during 2014, similarly BHP in Australia produced in excess of 200 million tons, Vale which is globally the biggest iron ore mine in Brazil delivered 314 million tons, Fortescue Metals Group (FMG) from Australia produced 124 million tons during 2014.

Further, despite a weaker global demand for key commodities the iron ore miners have refused to halt production, which is bad news for Cliffs Natural Resources. Moreover, the iron ore miners have now decided to produce even more with Rio Tinto moving from the production of 257 million tons in 2014 to 360 million tons, going forward. BHP has decided to go from 200 to 290 million tons. Vale is targeting to move from 314 million tons to 460 million tons. FMG is focused on achieving 160 million tons. Roy Hill would begin with 55 million tons, which is bad news for Cliffs Natural Resources.

The continuing weakness in the global commodity demand and pricing environment with only extremely weak recovery witnessed in the recent past coupled with the expanding iron ore production from the key mines across the globe is believed to continue to put downward pressure on the major commodities pricing, negatively impacting the mining companies key margins while forcing them to minimize non-core expenditures.

Weakness to consider

Both China and Rest of World are believed not to stop expanding steel production and thus, the world’s steel production is never expected to stop growing. According to the World Steel Association, the consolidated steel output of 1-billion-tons depicts the entire best-case situation from the perspective of iron ore production and is expected to need China to enhance its position for total export of steel products globally. Moving ahead, China is continuing to expand its total steel production by getting cheaper iron ore from the Australian mine, Rio Tinto. The continued enhanced steel production with low prices is increasingly being dumped in the US as China is producing steel in excess of its consumption capacity which is expected to continue in the near future and over the longer term as well.

China has recently slipped into a recession with its economic growth having slowed down to 7.4% and 7.0% during 2014 and 2015 respectively. Therefore, a significant production of all the commodities in China is not expected to be consumed in the country rather exported to the rest of the world and primarily to the US. China is continuing to flood the world with cheap steel and keeping several of their own high-cost iron ore mines open for production.

The excess production of steel by China amid weaker global commodity consumption is believed to further put downward pressure on the key commodities pricing, thus leading to the declining margins of the key metals producers.

Conclusion

Overall, the investors are advised to “Sell” any equity held in Cliffs Natural Resources Inc. considering the ongoing weaker global commodity demand and pricing environment which is believed not to yet have bottomed out coupled with the company’s weaker financial position with notable total debt of $2.57 billion and weaker total cash position of $59.90 million only, restricting the company to make future growth investments. The profit margin of 6.33% seems only satisfactory. The PEG ratio of 1.45 indicate weaker company growth, somewhat better than the industry’s growth average of 0.09 only.